STOCKS RALLY ON GOOD EARNINGS

Last week’s market had something for both the bears and the bulls, but the bulls won out again. The stock market was at a similar and even more important inflection point in early May (The Bull & Bear Tug Of War – Who Is Winning?) as the A/D lines were close to completing their corrections.The higher volatility in 2018 was expected to favor active, rather than passive, investors, but so far that has not been the case.  According to Bloomberg, in June, only 47% of large-cap funds beat the benchmarks, down from 52% in May.

Much of the poor performance of stock-pickers in 2018 can be attributed to the weak performance of the financial sector. The Financial Sector Select (XLF) is down 3.7% YTD, compared to the 4.1% gain in the Spyder Trust (SPY), which tracks the S&P 500.

Since the May lows, the divergences between the various market sectors have become even more pronounced.  The small-cap iShares Russell 2000 (IWM) has been leading the market since March, and is up 9.4% since the May lows, compared to a decline of 0.93% in the XLF.

The large-cap stocks have also lagged in the past two months, as the SPDR Dow Industrials (DIA) is up just 2.3%, less than half the gain in the SPY. It was thе rеlаtіvе реrfоrmаnсе (RS) аnаlуѕіѕ іn еаrlу Junе that іndісаtеd DIA was going to bе wеаkеr thаn the SPY. For many years, RS analysis has been an important method of identifying the strongest and weakest ETFs or stocks.  This type of analysis was the basis for my bullish outlook on the healthcare sector a few weeks ago.

Many are hoping that the upcoming earnings season will revive the financial sector, as JPMorgan Chase (JPM), Citigroup (C), and Wells Fargo (WFC) all report before the open on Friday, July 13. It seems like more than three months since they have reported, and even though JPM beat earnings expectations on April 11, the stock peaked that day at $114.11 and closed Friday at $104.06, down 8.8% from the high.

It has been a tough year for earnings, as many stocks that have exceeded the consensus expectations for earnings and revenues have still dropped sharply.  Based on the latest survey from the American Association of Individual Investors (AAII), only 27.9% of individual investors are bullish, with 39.3% bearish. The strong market action last week, along with the low level of bullishness, is a positive sign for the markets, showing many investors are still on the sidelines.

Guidance has become more significant in the last couple years, so even if you get a big beat on revenue and EPS, if the company suggests that the future is not so bright, the stock might fall off the cliff anyway.

Ultimately it all comes down to the market and valuation. Earnings reports are the market’s opportunity to reprice some stock based on old data and the company’s suggestions about the future. In the days following the report, as the market digests it, people move in or out according to their convictions and the stock price moves commensurately as people execute.